The Pathology of Europe’s Debt

German Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble before a vote on financial help for Greece, Bundestag, Berlin, November 2012

Today Europe is living through a difficult time. Germany’s finance minister, Wolfgang Schäuble, has called the recent elections for the European Parliament “a disaster,” going on to conclude that “all of us in Europe have to ask ourselves what we can do better…we have to improve Europe.” But what is happening in many parts of Europe today is not just a pathology; it is the predictable pathology that ensues whenever a country’s citizens suffer a protracted stagnation in their incomes and living standards.

The origins of this stagnation in large parts of Europe are broadly understood. Six years ago, Europe was caught in the backwash of the financial crisis created in the American mortgage market and the US banking system more generally. Problems that were already serious in one European country or another—fiscal imbalance, or eroded competitiveness, or an American-style construction boom, or a badly run banking system—made some parts of Europe especially vulnerable. The effects of the American recession exacerbated those problems wherever they existed. Then, in the familiar way, both monetary and fiscal policies in Europe did much to maintain stagnation. But a large part of the story is a failure to deal with the sovereign debt crisis that Europe has also now been confronting for more than half a decade, ever since it became clear that the governments of some European countries had borrowed money they could not repay.

The eurozone, consisting of eighteen European countries that use the euro as their currency, constitutes a remarkable experiment in this regard. The fact that it is a monetary union without a fiscal union behind it is entirely familiar. But a little-discussed implication of this anomaly is that the economy of the eurozone has no government debt. By “government debt” I mean obligations issued by a public entity empowered to print the currency in which the obligations are payable. All the other major economies we know—the US, the UK, Japan, Sweden, Switzerland, and many others—have government debt in this sense.

In the eurozone, by contrast, public sector debt is entirely what Americans call “municipal debt”—that is, obligations issued by public entities, in this case countries, that are not authorized to print the currency owed. It is this feature that makes the bonds issued by Massachusetts or New York or Texas subject to default in a way that US government debt is not. The bonds of all eurozone states, even those currently regarded as most secure, like Germany, are issued in euros and likewise subject to default in the same sense. It would be difficult to exaggerate how unusual an experiment this situation represents. I am unable to think of another modern example of a major economy with no government debt to anchor its financial structure.

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